General Electric (NYSE:GE) reported good first quarter earnings and seems on track to achieve its goal of double digit growth in 2012. The core industrial business grew 14%, of which 11% was organic growth. Earnings were up by 10% and the growth was fairly broad-based in both services and equipment sectors and across all geographic regions, except Europe. GE Capital continued to trim its balance sheet by eliminating risky assets. The segment’s earnings were up by 27%, excluding the impact of the sale of Garanti, while its real estate business turned profitable for the first time since the financial crisis. The order backlog in the industrial sector stood at a record $23.1 billion, representing a 20% growth over the prior year quarter. Organic orders were up 14%, marking eighth positive quarter of backlog growth.
GE competes with industrial conglomerates such as United Technologies Corporation (NYSE:UTX) and 3M (NYSE:MMM), among others. We have a price estimate of $20 for GE, which is slightly above the current market price.
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Although the earnings numbers are certainly impressive, they do veil certain important aspects of GE’s business which can be an impediment to its growth story.
Europe continues to be a weak spot
GE continues to struggle with its industrial business in Europe as the region economic weakness continues. The company’s medical imaging devices sales have been sluggish in the region while its housing appliances business has suffered due to poor housing starts. The European sovereign debt crisis looks set to flare further in the coming quarters, and GE’s performance here can prove to be a significant drag on its overall performance.
Operating margin growth slower than expected
The overall operating margin of GE’s non-financial business stood at 13.8%, a decrease of 0.5% from the prior year quarter. The increase in productivity was effectively countered by a margin decline from acquisitions. An unfavorable mix of equipment and services along with poor productivity in wind and thermal energy accounted for the remaining drop in margins. GE will have to take major steps to improve this margin and bring it close to its target of 14.8% by the end of this year.
Long cycle of industrial products still leave profits on the table
Orders for industrial products are typically placed well before their purchase, and they continue to stay in existence for many years. The majority of the profits for the industrial companies come from servicing these products during their life time. This is both a low volume and high margin business. Hence, while GE would have made profit on its sales of industrial products, its ability to boost this profit will depend on how many sales it’s able to convert into service contracts.